Struggling to finance expansions, more and more start-ups and established firms are looking to alternative forms of finance. One innovative method involves using business owners’ pension funds to release money in exchange for certain business assets being held in the pension as an investment asset.
Business Matters has spoken to Adam Tavener, of advisory firm Clifton Asset Management, to find out more about ‘pension-led’ funding..
How does it work?
In spite of Funding for Lending being designed to increase the amount of cash banks are lending small and medium-sized businesses, some firms eager to expand are still finding themselves arbitrarily rejected for business loans.
While these owners find it difficult to levy the cash they need to fund their ventures, at the same time they may very well have a decent-sized pension pot which, as an individual, they are unable to touch.
But they can however be used for business funding, through Sipp or SSAS pensions, and this can be done in two ways: through a commercial loan or an intellectual property purchase.
Quite often this can be done in conjunction with banks, who will become more amenable to a large business loan if the owner shows they’re willing to put some of their own capital at risk.
A commercial loan from the pension: This is a reasonably straightforward process of a business owners’s pension fund loaning money to the business, and being repaid with interest. Clifton Asset Management, which runs the pensionledfunding.com resource, facilitates business loans of up to five years from a pension fund.
The loan cannot exceed 50 per cent of the pension fund’s value, and must be paid back at an interest rate of at least one per cent higher than the Bank of England base rate. It can only be done via a SSAS with the approval of the scheme trustees, and not from a Sipp.
Intellectual property sale and lease: Although pension funds are banned from owning physical assets such as property and machinery, non-tangible assets such as intellectual property are a permitted asset class for pension-led funding.
The business owner’s Sipp or SSAS can purchase the intellectual property (IP) – such as domain names, patents, trademarks and copyrights – from their company, and lease it back to the business with the payments filling the hole left in the pension fund.
The purchase can exceed 50 per cent of the pension fund, but never 100 per cent. Around 70 per cent is about as high as you’re likely to get.
What are the benefits and risks?
Unlike taking a loan from the banks, you are not going to be hit with punitive charges, hounded, declared bankrupt and potentially lose your home if you default.
The owner, or at least their pension pot, takes on all the risk and those confident of business growth will be similarly confident of paying back the money to their pension pot.
What’s more, if you take the route of selling a firm’s IP to your pension, then the pension pot will grow as the business grows as the value of the intellectual property increases.
Upon retirement, this property can be sold back to the business at a profit, or can continue to provide an income as the business continues after the owner has put his feet up.
Gamble: Owners put their own retirement savings at risk when using pension-led funding, but if it goes well it could be lucrative.
And owners can repay the money to their pension sooner by increasing the amount they spend on the lease as the business becomes more profitable, with those payments gaining 100 per cent relief from corporation tax.
But obviously, if the business fails then its your pension pot that will take the hit in what would be a double whammy for the owner.
That said, if the business has sold its IP to the pension then all might not be lost, as this property may still retain an element of value even if the business goes under.
Is it appropriate for your business?
Any firm that facilitates a pension-led funding arrangement, not to mention the provider of the owner’s pension pot, will require reams of information before approving an application.
Clifton is one of few firms that can offer a comprehensive pension-led funding advisory service – which can be done in conjunction with an individual’s financial adviser. Those choosing to go direct to their pension provider will need to do so via their IFA.
No adviser or provider is going to agree to pension-led finance if the reason for the loan is to prop up a failing company, nor will it approve a loan or intellectual property purchase if the owner does not have a large enough pension pot.
An in-depth business case for the loan has to be presented, and a detailed assessment of company accounts, track record, business plan and funding structure carried out by a corporate finance and pension specialist.
When it comes to IP, Clifton appoints an independent valuer to assess how much could be levied from the pension pot from its sale.
The input of advisers becomes particularly important if the business owner is the member of a final salary scheme, with Clifton saying ‘caution should be exercised’ given the potentially generous nature of such pensions come retirement.
Similar caution should also be taken with pension pots that come with guaranteed annuity rates, spouse benefits and transfer penalties.
How much does it cost?
The costs will vary depending on how much an owner’s financial adviser charges for their services.
Clifton, meanwhile, provides a service that includes reviewing the business, carrying out due diligence, valuation of IP, checking compliance, and a final audit for a flat-fee of £3,600 for an IP lease – plus 4.8 per cent of the transaction amount (ie. £4,800 from a £100,000 transaction).
This falls to £3,000 for a commercial loan – plus the 4.8 per cent.
That means releasing £100,000 to buy IP would cost a hefty £8,400. However, these are flat fees – the longer the company takes to repay the money, the cheaper this money effectively is.
Clifton argues its charges are broadly similar to the interest costs of taking out a typical business loan. Although you pay interest on loans taken from an owner’s pension pot, the money is being paid back to the owner themselves so it doesn’t cost anything extra.
Have others made a success of it?
The option has been open to businesses for many years, but Clifton says the past few years of economic struggle has prompted a rise in firms looking for alternative ways to raise cash, even if many are still unaware of pension-led funding.
Clifton’s Adam Tavener said: ‘This is about generating wealth for the business and the business owners, it’s not a tax-planning exercise.’
One of the most publicised cases of successful pension-led funding is that of Cumbria-based Dick Cormack, who raised £75,000 from his pension pot to fund his rally tyre business DMACK Tyres.
He was matched with a further £75,000 loan from HSBC which allowed his firm to manufacture its own branded tyres for the World Rally Championship.
As of the end of 2012 he was predicting sales would increase from £1million to £6million by the end of the financial year.